Stock Market Outlook For 2023

 It’s official, 2022 has been the worst year for the S&P 500 in more than a decade.

The index is on track to close out the year down more than 17%. That’s the S&P 500’s first double-digit percentage annual loss since the Great Recession, when the index slid 38.4% in 2008.

But if you take the long-term view, years like these are aberrations—and they can also be excellent long-term buying opportunities.

To put it into perspective, the S&P 500 hasn’t seen back-to-back down years since the bursting of the dot-com bubble in 2001 and 2002. The index has typically delivered an average annual gain of 9% since 1996.

Unfortunately, the dual headwinds of high inflation and Federal Reserve interest rate hikes won’t be going away in the near term. But if the Fed manages to get inflation under control and navigate a soft landing for the U.S. economy, analysts say 2023 could be a much better year.

2023 Outlook for Stocks

Higher interest rates are bad news for stock prices. They increase the cost of capital, which discourages companies from borrowing and investing to expand their businesses.

The bad news for investors is that earnings growth tends to stagnate. There’s also a negative impact on discounted cash flow valuations, which can hurt high-growth stocks.

Growth Stocks

It’s been a tough year for stock prices across the board in 2022, but rising rates have been particularly hard on growth stocks. In fact, the Vanguard Growth ETF (VUG) has significantly underperformed the S&P 500, generating a -27.8% total return year to date.

Since 2000, growth stocks have outperformed value stocks by a wide margin overall. But growth stocks underperformed value stocks from 2003 to 2007, another period of sharp interest rate increases.

Value Stocks

While growth in stock valuations has tumbled in 2022, value stocks have held up relatively well. In fact, the Vanguard Value ETF (VTV) has generated a total return of just -1.7% year to date.

As far as investors are concerned about market volatility, geopolitical and economic uncertainty, and rising interest rates, they will likely continue to seek relative safety in value stocks.

Thomas Shipp, quantitative equity analyst for LPL Financial, says value stocks will likely continue to outperform until interest rates fall significantly from current levels.

“A slower pace of smaller rate hikes, and ultimately a pause in the hiking cycle, will be headwinds to value’s relative performance,” Shipp says. “But until there is a clear path that inflation is sustainably headed toward the Fed’s 2% long-term target, value has a good chance to outperform growth.”

Shipp notes that LPL’s Strategic & Tactical Asset Allocation Committee continues to tilt toward value from an asset allocation perspective.

Stock Market Sectors

Elevated inflation and rising interest rates have hit some stock market sectors harder than others.

Global energy shortages linked to the Russo-Ukrainian war have helped the energy sector post record gains. The S&P 500 Energy sector is up 70.3% in 2022, and it’s the only market sector that has generated positive year-to-date gains.

In addition, defensive market sectors that have relatively stable earnings outlooks—consumer staples, utilities and health care—are all down less than 6% on the year.

Darren Colananni, wealth management advisor at Centurion Wealth Management, says the S&P 500 may struggle in gaining much traction in 2023 as interest rates remain high. Colananni’s year-end 2023 S&P 500 price target is only 3,700, around 7% below current levels.

Colananni says investors should focus on sectors that have the most projected earnings growth in 2023. In particular, he is bullish on consumer discretionary stocks and industrials.

“For consumer discretionary, we are thinking of companies like Starbucks, McDonald’s, Amazon, and Disney. For industrials, we are thinking of companies like 3M, FedEx, and Waste Management,” Colananni says.

Wells Fargo anticipates a weak economy in the first half of 2023. Samana prefers the earnings power of energy stocks, tech and health care.

“These companies have strong quality and profitability characteristics that should help them weather rising rates and the recession we see in the first half of next year,” he says.

While recession can be a scary word for investors, Wells Fargo sees a light at the end of the tunnel in the second half of 2023. The firm’s year-end S&P 500 price target is 4,300 to 4,500, implying roughly a 10% upside from current levels.

Global Stock Market Dip or Peak ?

 After a week of wild turbulence, stocks are likely to remain volatile as investors await fresh data on inflation and watch the course of bond yields.  The three major indexes started the week with three straight positive sessions, then plunged in a sharp selloff after investors decided the Federal Reserve's implied policy tightening cycle ahead was still very hawkish, even as Chairman Jerome Powell took 75-basis point rate hikes off the table. In its biggest one-day loss in two years, the benchmark S&P 500 Index plunged 3.6% on Thursday, the Dow lost 1,063 points and the tech-heavy Nasdaq closed the session down 5%.

The S&P 500 index has now declined for five straight weeks, its longest streak since mid-2011, and closed at 4,123, down just .2% for the week.  The Nasdaq lost -1.5% to close at 12,145 and is now down almost 25% from its record set last November.  The DOW lost -.2% to 32,899 and the Russell 2000 lost -1.3% to 1,839.  With all the volatility the market experienced, the CBOE VIX actually dropped -9.6% on the week to 30.19.

More volatility could be in store if this week's monthly consumer price index reading exceeds expectations, potentially propping up the case for even more aggressive monetary policy tightening from the Fed.  The Fed raised its fed funds target rate by 50 basis points, the largest increase in 22 years, and signaled similar hikes are on the way. They also said it would start next month to reduce the roughly $9 trillion stash of assets accumulated during its efforts to fight the economic impact of the coronavirus pandemic as another lever to bring inflation under control.  Markets will be closely watching Wednesday’s April consumer price index to see if it will impact the Fed’s future decisions. Economists expect another high inflation reading but most likely lower than the 8.5% year over year pace of March.  The producer price index, which is a gauge of wholesale prices will be released Thursday.

The benchmark S&P 500 index is now down 13.5% year-to-date and valuations stand at their lowest levels in two years, putting the index's forward price-to-earnings ratio at 17.9 times from 21.7 at the end of 2021, according to the latest data from Refinitiv Datastream.

Higher yields in particular dull the allure of technology and other high-growth sectors, as their cash flows are often more weighted in the future and diminished when discounted at higher rates.  The 10-year Treasury yield broke through 3% for the first time since November 2018 and on Friday hit a high of 3.13%, up from 2.94% a week earlier. The 10-year was approximately 1.5% at the start of the year. This has caused the forward P/E for the S&P 500 technology to decline from 28.5 times to 21.4 so far this year, according to Refinitiv Datastream.

States Begin to Drop Orders For Masks in Public Settings

 Nine states outlined plans this week to roll back requirements that people wear masks at indoor venues—including businesses and, in some cases, schools—as Covid-19 case numbers decline and pressure to return to normal life rises.

Officials in New York, Illinois, Massachusetts and Rhode Island said Wednesday that rules requiring masks or proof of vaccinations intended to curb the spread of the Covid-19 pandemic would end by March. Earlier in the week, California, Oregon, New Jersey, Connecticut and Delaware officials made public similar rollbacks.

All of those states voted for President Biden in the 2020 election and are now not following recommendations from the federal Centers for Disease Control and Prevention, after previously hewing to guidance to continue requiring face covering indoors and in schools.

“The Covid clouds are parting,” New York Gov. Kathy Hochul, a Democrat, said after announcing requirements to wear masks in restaurants and offices would lapse on Thursday.

Federal public-health officials said Wednesday that they are considering changes, but continue to recommend mask-wearing in public indoor settings in much of the country.

Why 7% Inflation Today Is Far Different Than in 1982

 Consumer price inflation in December, at 7%, was last this high in the summer of 1982. That’s about all the two periods have in common.

Today, the inflation rate is on the rise. Back then, it was falling. It had peaked at 14.8% in 1980, while Jimmy Carter was still president and the Iranian revolution had pushed up oil prices. Core inflation that year reached 13.6%.

Upon becoming Federal Reserve chairman in 1979, Paul Volcker set out to crush inflation with tight monetary policy. In combination with credit controls, that effort pushed the U.S. into a brief recession in 1980. Then, as the Fed’s benchmark interest rate reached 19% in 1981, a much deeper recession began. By the summer of 1982, inflation and interest rates were both falling sharply. Four decades of generally low-single-digit inflation would follow.

“We have had dramatic success in getting the inflation rate down,” one Fed official observed that August. But Mr. Volcker had other problems to contend with: His high interest rates had pushed Mexico into default, touching off the Latin American debt crisis, and unemployment would climb to a post-World War II high of 10.8% that fall.

Unemployment took out that record in the early months of the Covid-19 pandemic in 2020. Since then, it has been falling rapidly as the economy roars back thanks to vaccines, fewer restrictions on mobility and ample fiscal and monetary stimulus. In December, unemployment sank to 3.9%, closing in on the 50-year low of 3.5% set just before the pandemic.

Monetary policy then and now couldn’t be more different. Back in 1982, the Fed was still targeting the money supply, causing interest rates to fluctuate unpredictably. Today, it largely ignores the money supply, which expanded dramatically as the Fed bought bonds to hold down long-term interest rates. Its main policy target, the federal-funds rate, is close to zero.

Rather than 1982, two previous episodes when inflation reached 7% might hold more useful lessons for today. The first was in 1946. The end of the war had unleashed pent-up demand for consumer goods, and price controls had lapsed. Inflation reached nearly 20% in 1947 before falling all the way back. Today, consumption patterns have similarly been distorted and supply chains disrupted by the pandemic.